Appraisers Guide to CMBS and the Debt Capital
® Appraiser’s Guide to CMBS and the Debt Capital Markets Presentation to: The Appraisal Institute – AI Connect 2015 Proprietary & Confidential July, 2015 Page 1
Objective ® Presented by: Steve Powel, Chief Executive Officer of Situs Constantine “Tino” Korologos, MAI, CRE Managing Director of Situs , Proprietary & Confidential Page 2
Todays Outline 1. 2. 3. 4. 5. 6. 7. 8. ® Introductions History of the CMBS Markets Brief look at the Debt Capital Markets “Alphabet Soup” 1. Definitions - terminology 2. Who are the players and what do they do How does the CMBS Market Work 1. CMBS Bond Structures 2. What’s the Process? 3. How does the Appraiser fit in? The Rating Agencies 1. What do they do in the process? 2. How do they look at Appraisals? Case Study on a large loan CMBS deal – 200 Park Avenue, NY Questions Proprietary & Confidential Page 3
Introduction to CMBS ® • Commercial Mortgage Backed Securities (CMBS) are bonds backed by pools of mortgages on commercial and multifamily real estate. As of June, 2015, the US market capitalization of the CMBS market was $746 Bn. • CMBS offer several advantages over commercial whole loans. Securitization allows for the division of the loan into credit classes so that an investor may buy a class rated from AAA to B and unrated. • CMBS are marked to market on a daily basis and hence are more liquid than whole loans. CMBS appeal to a wide array of investors because of attractive relative spreads and stronger call protection than residential mortgage securities. US CMBS Outstanding Standard Property Types Source: Trepp, Morgan Stanley Research Proprietary & Confidential Page 4
® History of the CMBS Market Proprietary & Confidential Page 5
History and Development of the CMBS Industry ® • Before the mid-1990 s the U. S. real estate business was predominantly a private market. • Lending was dominated by a handful of banks, life insurance companies, and pension funds. • Real estate ownership was regionally focused, with ownership concentrated in a few hands. Families and private partnerships were the largest owners. • In the real estate recession of the late 1980 s and early 1990 s, commercial real estate prices fell by 50% or more in some areas, and delinquency rates on loans soared to all-time highs. • Losses led to the exit of many traditional lenders from the commercial mortgage market. • Regulators and rating agencies turned more negative on commercial mortgage holdings, so that the remaining lenders became less willing to extend credit. • Low real estate values combined with the failure or exit of traditional lenders provided innovation opportunities and a shift from private to public ownership. • REITs began buying undervalued real estate portfolios funded through public stock and bond offerings. REIT shares provided an opportunity for small, diversified investments in real estate. • Investment banks started to apply securitization legal structures developed during the 1970 s and 1980 s for residential mortgage-backed securities (RMBS) to commercial mortgages. In the mid- to late-1980 s, issuers securitized a few loans on single properties into CMBS. • Packaging of diversified pools of mortgages into CMBS developed in the mid-1990 s when the Resolution Trust Corporation (RTC) pooled non-performing loans from failed institutions. • Some transactions exceeded $1 billion and led to the growth in the investor base for CMBS. Source: Morgan Stanley Research Proprietary & Confidential Page 6
Historical CRE (all) Debt Originations by Year Proprietary & Confidential ® Page 7
Historical CMBS Originations by Year (Trailing 12 mo) Proprietary & Confidential ® Page 8
Historical CRE Debt Originations by Year Proprietary & Confidential ® Page 9
CMBS Loan Maturities… what lies ahead Proprietary & Confidential ® Page 10
® Brief Introduction to the Real Estate Capital Markets Proprietary & Confidential Page 11
Capital Markets Debt Market Composition ® Source: Federal Reserve Bank 12 Proprietary & Confidential Page 12
Capital Markets Transaction Activity ® 13 Proprietary & Confidential Page 13
Capital Markets Overview ® Definition of capital markets • The marketplaces where money is raised and securities are traded • A place or system in which the requirements for capital of a business can be satisfied • Capital markets include stock markets (equity) and bond/credit markets (debt) Credit ratings are a very important part of the credit markets and are used by: • investors; issuers; commercial banks; investment banks/broker-dealers; government agencies. A classical approach to the real estate capital markets considers a simple “debt” and “equity” construct • “ 4 quadrants of capital” 14 Proprietary & Confidential Page 14
Capital Markets – Real Estate ® Public Debt & Public Equity: Private Debt & Private Equity: Ø Commercial Mortgage-Backed Securities (CMBS) Ø Collateralized Debt Obligations (CDOs) Ø Real Estate Investment Trusts (REITs) Ø Mutual Funds ØWhole Loans ØMezzanine Loans ØB-Notes (Subordinate to I-grade portion of mortgage debt) ØLimited Partnerships ØPrivate REITs ØSeparate Accounts However, the capital markets have become much more complex in nature…. . 15 Proprietary & Confidential Page 15
Capital Markets Securitization ® Structured Finance is a (relatively new) subsector of finance that was developed to transfer risk using a complex legal framework Securitization • Is the process of taking an illiquid asset, or group of assets, and through financial engineering and legal definitions, transforming them into a tradable, liquid securities. • A structured finance technique that pools assets together and, in effect, turns them into a tradable securities held by a bankruptcy remote special purpose vehicle (SPV). Financial institutions and businesses of all kinds use securitization to immediately realize the value of a cash-producing asset; recognizing the arbitrage stemming from illiquid/liquid investments. The securitization of real estate takes multiple forms: • Real Estate Investment Trusts (REITs) • Commercial Mortgage-Backed Securities (CMBS) • Collateralized Debt Obligations (CDO’s) • Residential Mortgage-Backed Securities (RMBS) The securitization of real estate finance has blurred the lines of the 4 -quadrants approach to capital markets • Risk Spectrum approach evaluates and prices “risk” rather than “debt” or “equity” 16 Proprietary & Confidential Page 16
® “Alphabet Soup” Terminology and the Players Proprietary & Confidential Page 17
Definitions & Terminology Advances “B Piece” CMBS Defeasance Haircut Investment Grade Loss Severity Mezzanine Debt Pooling & Servicing Agreement Qualified Institutional Buyer Realized Loss Senior/Subordinate Structure Special Purpose Entities (SPE) Tranche Yield Maintenance ® Appraisal Reduction ASERS Bankruptcy Remote Entity Call Protection Conduit Credit Enhancement Depositor First Loss Piece Independent Director Interest Only Strip (IO) Liquidation Fee Lock-Box Provision Master Servicer Master Servicing Fee Non-Consolidation Opinion Pari Passu Loan Private Placement Prospectus REMIC (Real Estate Mortgage Investment Conduit) Reps and Warranties SEC Rule 144 A Services Servicing Advances Special Servicer Subordination Trustee Waterfall Proprietary & Confidential Page 18
Who are the Players and what do they do ® Borrowers Mortgage Loan Originator, Mortgage Bankers and Brokers Loan Sellers Depositors Rating Agencies Subordinate Bond Holders – Controlling Class Bond Holder Investment Grade Certificate Bond Holders Third Party Servicers (Master Servicers, Special Servicer & Operating Trust Advisor Trustee Proprietary & Confidential Page 19
® How does the CMBS Market work? Proprietary & Confidential Page 20
CMBS Transactions Flow of Investments & Securities ® Source: CREFC Proprietary & Confidential Page 21
® Where the Money Goes Mortgage lien and Assignments of Rents and Leases Loan Originator / Loan Seller (Lender) Loan Proceeds Mortgage Notes Borrowers Debt Service & Escrows Servicer. Collection Account Debt Service Less Servicer Fee Plus Advances Securities Sale Proceeds at Closing Trustee. Distribution Account Monthly Bond Coupon & Principal CMBS Bonds Securities Sale Proceeds at Closing Securities Investors 8 Proprietary & Confidential Page 22
® CMBS Architecture • CMBS have very simple structures compared to their residential mortgage counterparts. • Each tranche represents a security with its own credit rating, average life, and other characteristics. • Bonds are almost always sequential pay: amortization, prepayments, and default recoveries are paid to the most senior remaining class. The lowest-rated remaining class absorbs losses. • Unlike their residential counterparts, commercial mortgages almost always have some form of prepayment penalty, making credit analysis more important than prepayment analysis. • A CMBS investment requires analysis on three levels: property, loan, and bond. Properties Mortgages Asset Pool Property 1 Mortgage 1 Property 2 Mortgage 2 Property N Mortgage M Real Estate Mortgage Investment Conduit (REMIC) Liabilities AAAAAA AA NR Source: Morgan Stanley Research Proprietary & Confidential Page 23
CMBS Structure and Participants Proprietary & Confidential ® Page 24
® Post-closing Investors Trustee/ Fiscal Agent Investors Bonds traded in the secondary market by Investors $ Investment Bank/ Secondary Traders Trust $ Borrowers $ Master Servicer Primary or Sub-Servicer / Mortgage Banker Special Servicer 7 Proprietary & Confidential Rating Agencies Continue to rate bonds Page 25
The CMBS “Playbook” – the Pooling and Servicing Agreement ® What is the Pooling & Servicing Agreement (PSA)? The PSA is a multifunctional document executed by the Depositor, Trustee, Master Servicer, Special Services and Trust Advisor which implements: • Creation of the CMBS trust the owns the loans • Conveyance of the loans along with the assignment of rights & remedies of the depositor against the seller of the loans. • Appointment of the parties mentioned above and the detailed provisions governing the rights and obligations of the parties and the certificate holders. • Issuance of certificates of the beneficial interest in the CMBS Trust with the priorities and rights to payments for each class of investor. • Waterfall distribution • Rights, duties and obligations of the parties. • Election by the CMBS trust to be treated as a REMIC for purposes of Federal Tax • Definitions and provisions including the application of the appraisal process. Proprietary & Confidential Page 26
Appraisal Reductions – ARA and ASER ® What is an appraisal reduction? Appraisal reductions allow for a reduction of servicer advances for a loan that is expected to suffer a loss. To calculate those reductions, the special servicer obtains an independent third party appraisal. Such events are triggered by specific loan events as defined in the PSA. Examples might be 120 days of delinquency, 60 days delinquency after a borrower bankruptcy, or immediately after a loan becomes REO. What is ARA? Appraisal reduction amount generally equals the excess of the sum of the unpaid principal balance, unpaid servicer advances and other charges over the sum of 90% of the appraised value with the amounts of reserves, escrows & LOCs So a $10 m UPB and other charges, with a $9 m appraised value with $200 k reserves would be the excess of $10 m over 90% of $9 m ($8. 1 m) plus $200 k or $1. 7 m. What is an ASER? The Appraisal Subordinate Entitlement Reduction is the difference between the old and new monthly advances after the ARA was taken. Appraisals are generally updated every year and any further decreases in value would increase the ASER. Proprietary & Confidential Page 27
Addenda ® The Rating Agencies Proprietary & Confidential Page 28
What are the Rating Agencies and what do they do? ® What is the definition of a Credit Rating Agency? As defined by the U. S. Securities and Exchange Commission, a credit rating agency is defined in the Rating Agency Act to be a person (a) engaged in the business of issuing credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee, but does not include a commercial credit reporting company; (b) employing either a quantitative or qualitative model, or both, to determine credit ratings; and (c) receiving fees from either issuers, investors, or other market participants, or a combination thereof. NRSRO is a Nationally Recognized Statistical Rating Organization. Who are the Major Rating Agencies? Moody’s Investors Service, Fitch Ratings, Standard & Poor's, Kroll Ratings, Morningstar Ratings, DBRS (Dominion Bond Ratings Service) What is a Rating? A Rating is an opinion … just the way an appraisal is an opinion. But protected under the First Amendment AAA Determined to have almost no risk of loss due to credit-related events. Assigned only to the very highest quality obligors and obligations able to survive extremely challenging economic events. AA Determined to have minimal risk of loss due to credit-related events. Such obligors and obligations are deemed very high quality. A Determined to be of high quality with a small risk of loss due to credit-related events. Issuers and obligations in this category are expected to weather difficult times with low credit losses. BBB Determined to be of medium quality with some risk of loss due to credit-related events. Such issuers and obligations may experience credit losses during stress environments. BB Determined to be of low quality with moderate risk of loss due to credit-related events. Such issuers and obligations have fundamental weaknesses that create moderate credit risk. B Determined to be of very low quality with high risk of loss due to credit-related events. These issuers and obligations contain many fundamental shortcomings that create significant credit risk. Proprietary & Confidential Page 29
Rating Agencies – The Meltdown and Regulations ® Rating Agency Reform - Credit Rating Agency Reform Act passed in 2006 Since the financial crisis regulators have encouraged “unsolicited” opinions on deals. Ideally this would cut down on ratings shopping The Dodd-Frank act enhanced the SEC’s enforcement mechanisms for credit rating agencies (NRSRO) o Establish maintain, enforce, and document internal control structures governing implantation of and adherence to policies, procedures, and methodologies for determining credit ratings. An annual report of must be submitted to the SEC o The SEC may suspend or permanently revoke the registration of a NRSRO for a particular class or subclass of securities if they cannot consistently produce reports with integrity o Sales and marketing decisions are strictly prohibited from influencing the production of ratings o Review of work when a credit analyst leaves a NRSRO and if the prospect of future employment influenced their work. These reviews must be formalized and the SEC will review the NRSROs policies at least annually and whenever such policies are materially modified or amended o NRSRO’s must report to the SEC if new employees previously worked at another NRSRO in a credit rating capacity o Complete public disclosure of the NRSRO’s initial credit ratings and changes to credit ratings Enhances the disclosure of transition and default rates; Standardizes those rates within NSRO’s o Compensation of each compliance officer is linked to financial performance of the NSRO in such a way to ensure independence of the officer’s judgement o Public Disclosure of procedures and methodologies including qualitative and quantitative data and models Must promptly publish any changes to those things, why and the likely changes to current ratings as a result Notice of significant error in existing procedures and methodologies Disclose the version of the credit rating procedure or methodology used for a rating o Disclose with each rating essential qualitative and quantitative information as well as the methodology to give transparence to investors and includes key assumptions and possible limitations Proprietary & Confidential Page 30
Rating Agency Process – Office Properties ® Rating Agency Cash Flow Evaluation… consistently applied over time Source: Kroll Bond Rating Agency Proprietary & Confidential Page 31
Rating Agency Process ® Rating Agency Valuation Thresholds – All LTV’s aren’t created equal Source: Kroll Bond Rating Agency Proprietary & Confidential Page 32
Rating Agency Process – Sample Office Loan ® KLTV Thresholds for a High Leverage Loan in a SASB Transaction Source: Kroll Bond Rating Agency Proprietary & Confidential Page 33
Addenda ® Case Study – Single Borrower CMBS Deal 200 Park Avenue, New York, NY Proprietary & Confidential Page 34
Case Study – SASB Deal 200 Park Avenue, New York, NY Proprietary & Confidential ® Page 35
Case Study – SASB Deal 200 Park Avenue, New York, NY ® Source: KBRA Presale report BAML 2015 -200 P Proprietary & Confidential Page 36
Case Study – 200 Park Avenue, New York, NY ® Source: KBRA Presale report BAML 2015 -200 P Proprietary & Confidential Page 37
Case Study – SASB Deal 200 Park Avenue, New York, NY ® Source: KBRA Presale report BAML 2015 -200 P Proprietary & Confidential Page 38
Case Study – SASB Deal 200 Park Avenue, New York, NY ® Source: KBRA Presale report BAML 2015 -200 P Proprietary & Confidential Page 39
Case Study – 200 Park Avenue, New York, NY ® Source: KBRA Presale report BAML 2015 -200 P Proprietary & Confidential Page 40
Addenda ® Addenda Proprietary & Confidential Page 41
Who We Are ® Global Operations Strategic Outsourcing Solutions for the Financial Services Industry United States Atlanta Boca Raton Des Moines Houston New York Robbins, NC San Francisco • Founded in 1985 • Involved in onetrillion+ dollars of CRE-related transactions • More than 600 employees • REFI Advisor of the Year Award • Over $100 billion of assets under management in US and Europe • In 2015, Situs was acquired by Stone Point Capital CRE Advisory CRE Fulfillment Servicing • Focused on process support, platforms and servicing/asset management • Solutions address full spectrum of finance industry, including investment life cycle, deal execution, transformation consulting and asset management platform Consulting Solutions Proprietary & Confidential Valuation Europe Copenhagen Dublin Frankfurt London Madrid India • Blue chip customer base • Partner platforms with clients improve cost by leveraging lower-cost environments Technology Page 42
What We Do ® CRE Advisory • Loan Sizings/Screenings • Mark to Market Analysis • Scenario Analysis • Securitization Support • Due Diligence & Asset Underwriting (balance sheet and all CMBS tranches/structures • Agreed Upon Procedures (AUP) • Asset Evaluation & Cash Flow Modeling • Lease Abstraction • Variance Analysis • PI & LC Rollover Analysis • Loan Closing Support Asset/Loan Servicing F. I. G. Solutions Master Servicing Primary Servicing CMBS Special Servicing NPL, Asset Management and Workouts Asset and Portfolio Administration Payment Processing & Cash Management • Construction Management & Draw Processing • Warehouse Line Underwriting and Servicing • • CCAR / DFAST • Data Aggregation • • Valuation / Analysis ALLL / Probable Loss Derivations M&A Due Diligence/Valuation Data Aggregation Regulatory/Compliance Audits Portfolio De-risking Strategies Loan Credit Administration, Loan Risk Rating Analysis /Support Document Imaging/Scanning/Indexing Valuation Solutions Technology Solutions • Valuation Management System • Process Management, Bidding & Engaging Appraisers, Document Management, Reporting, and Audit Support • Valuation Advisory • Fiduciary Services • Portfolio Valuation & Analysis, Debt Valuation and Fairness Opinions • Appraisals, Market Studies and Tax Consulting • Purchase Price Allocations • Situs INSIGHT Market Information Management • Situs RERC VMS Valuation Management System • CLOSER* Underwriting/Asset Management Database • MIDAS Proprietary, Web-Based Special Servicing System • Research Publications/Data. Center *affiliate business with CJC Technologies Proprietary & Confidential Page 43
How We Do It ® With 30+ years of tried & tested business practices, Situs provides experienced execution platforms which augment our client/partner’s team Scalability & Variable Staffing Model • Established business practices allow team to quickly scale “as needed” resources • Seamless management of the peaks and valleys of your business • Improved staff efficiency – right-sized team Competitive Cost Model Leveraging Lower-Cost Environments • 15 offices across the US and Europe, including three operations centers • Lower cost model, that leverages geography, quality & time zones Customized Solutions Comprehensive Execution Strategies • Flexible delivery models – on premise or off premise; dedicated, semi-dedicated or project-based support • Experienced professionals including multiple product specialists – Valuation, Hotel, Multifamily, AUP, Lease Abstract & Portfolios • Short-term project requirements with our 600 experienced real estate professionals • End-to-end life cycle solutions Proprietary & Confidential • Skilled and tenured team, leveraging over 30 years of Situs’ experience with enhanced work product quality Page 44
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